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Why does everyone want corporate bonds? One word: Alpha.

Why does everyone want corporate bonds? One word: Alpha.

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Why the intense scrum for new-issue corporate bonds? It’s not just the yield on offer from buying the new debt. It’s the fact that that yield, for a brief but important moment in time, exceeds the benchmark.

Here’s a little Bloomberg post based on research from Citigroup credit strategist Jason Shoup.

He estimates that investors can add 20 basis points of alpha just by purchasing new-issue bonds.

… Alpha has been scarce in recent years. More than half a decade of ultra-low interest rates and extraordinary monetary stimulus from the world’s central banks means that many assets are moving in tandem, making it more difficult for investment managers to find alpha-generating opportunities. If assets were racing they’d be neck and neck, so to speak.

However, one place where alpha can be generated is in the corporate bond market where big companies sell their debt. The reason is simple. When companies sell a new bond there is typically a lag between the bond being issued and when it’s included in benchmark fixed income indexes …

The simple reason why everyone wants new corporate bonds

One last (FT) look at the corporate bond market

One last (FT) look at the corporate bond market

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This is my last big story for the Financial Times, as I’m heading off to a brand new gig at Bloomberg. The piece seeks to bring together a lot of what I’ve written about bond market liquidity, the rampant search for yield and the growing power of big buyside investors into a single narrative. Do read the full thing if you can.

Dan McCrum at FT Alphaville also has an excellent summary.

I’ve left some key excerpts below:

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New column – The unbearable tightness of benchmarks

New column – The unbearable tightness of benchmarks

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Benchmarks.

Their importance in financial markets cannot be overstated. So here’s a look at how the makeup of one particular benchmark bond index is making life difficult for big investors and in some cases encouraging them to use derivatives to introduce artificial duration to their portfolios.

(Writing about duration is always a huge hassle, but it too is very important in financial markets, so I try)

Here’s an excerpt:

If there were a recipe for creating the Barclays US Aggregate Index — one of the most important benchmark bond indices in the world — it might go something like this: take some US Treasuries, add a smattering of corporate bonds and securitised debt, then fold in a large chunk of mortgage-backed securities. Mix it all together et voilà — you are ready to serve a heaping portion of fixed income exposure to hungry investors around the world.

Fund managers are like chefs, trying to follow this basic recipe and improve on the outcome where possible — baking the basic bond fund cake, but adding their own twist to beat the benchmark. (After all, if you are simply replicating the benchmark’s returns, you had better be chargingvery low fees.)

However, fund managers seeking to outperform the Barclays “Agg” face a unique problem in the market in the shape of a severe lack of ingredients, and there are lurking concerns as to just what exactly fund manager cooks are reaching for in the kitchen.

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Bond index mix creates ingredient shortage

Creating liquidity from illiquid stuff

Creating liquidity from illiquid stuff

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A quick take on a long-running theme in markets, especially fixed-income.

Investors are reaching for a toolkit of exchange traded funds, mutual funds and credit derivatives to make up for a dearth of liquidity in parts of the financial system, according to market participants and research from Barclays.

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Many have turned to ETFs, mutual funds and certain derivatives to make up for a lack of liquidity. ETFs use a network of banks and trading firms to give investors cheap and instant exposure to a wide variety of assets.

The trend is particularly pronounced in the fixed income market, where new rules aimed at increasing bank capital and reducing the risk of a run in the “repo market” — Ground Zero for the financial crisis — are said to have most hurt ease of trading.

Risks squeezed out of banks pop up elsewhere

 

New column – Asset managers, repo and derivatives. Oh my!

New column – Asset managers, repo and derivatives. Oh my!

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Chances are, when you think of the repo market you think of banks and broker-dealers and the craziness that went down in 2008. This column, based on an amazing research paper by Zoltan Pozsar, suggests that’s a mistake.

(Bonus: It calls out Pimco on window-dressing its balance sheet)

Here’s an excerpt:

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About all those high-yield energy bonds…

About all those high-yield energy bonds…

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I’m not an energy person. So I was delighted to learn about reserve-based lending and the semi-annual “redetermination of the borrowing base” procedure that oil companies undertake with their bank lenders.

It’s no secret that energy companies have borrowed heavily from Wall Street to fund their shale exploration. With the price of oil halved from its peak last year, those companies are under pressure. One place this is showing up is in the world of bank credit lines to energy firms, and also junk-rated bonds they sold.

There is lots of information in the below article, including talk of the hedge funds and private equity firms waiting in the wings to “rescue” energy firms on potentially punitive terms. One thing I would like to stress is a rather unsavory dynamic at play here. If energy companies have to turn to second-lien financing to plug holes in their bank loan facilities, the claims of existing unsecured creditors – i.e bondholders – get pushed further down the payment hierarchy. Because so many of these bonds have been issued on a cov-lite basis, subordinating them becomes even easier. In short, there are interesting times ahead for the high-yield energy sector.

April in Texas traditionally marks the start of the spring thunderstorm season. This April, the tempestuous weather looks set to be accompanied by an additional financial squall for the state’s oil and gas companies as banks begin cutting back on the reserve financing on which these firms rely.

Such financing is typically re-evaluated twice a year, usually in October and April, and is tied to the value of the borrowing firms’ oil and gas reserves and related assets such as pipelines.

With the price of US crude now less than 50 per cent of its recent peak of $107 a barrel, the likely consequence is that banks will significantly reduce their lending to energy firms across the US, forcing companies to look for alternative sources of financing on more punitive terms.
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Energy bondholders at risk as bank loans ebb
Energy bondholders could lose out in refinance deals
A dozen ways to stretch your borrowing base

New column – Won’t somebody please think of the bond funds?

New column – Won’t somebody please think of the bond funds?

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Bond inventories held by dealer-banks have halved since 2007 blah blah blah.

What gets far less attention than bank balance sheets in the bond market liquidity puzzle is the other side of the equation, and that is the astounding growth of bond funds.

This column, based on a big BIS paper, has some big numbers to go along with it.

The BIS estimates that the bond holdings of the 20 biggest asset managers have jumped by $4tn in the four years immediately following the crisis. By 2012 the top 20 managers held more than 60 per cent of the assets under management of the 300 biggest bayside firms in 2012, up from 50 per cent in 2002.

In other words, while asset managers are increasingly concentrated in bonds, the asset management industry, in turn, appears to be increasingly dominated by a select group of elite managers.

… The issue of decreasing levels of liquidity in the bond market was recently highlighted by the Bank for International Settlements, better known as the central bank’s bank, which last week released a 57-page paper with the rather dry title of “Market-making and proprietary trading: industry trends, drivers and policy implications”.

Yet the dearth of traditional market makers is only one half of the liquidity story.
The other is the astounding growth of big bond funds, which in recent years have ridden a wave of low interest rates and a period of huge debt issuance by governments and companies to grow their balance sheets by staggering amounts.

Many of these funds have been herded into similar investment positions thanks to the increasing use of benchmarking, as well as ultra low interest rates, which have essentially encouraged them to “go long” on credit. Moreover, in an environment of one-sided demand for bonds, few fund managers have had to pay for their liquidity in recent years.

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Liquidity puzzle lurks within bond funds’ extraordinary rise

Did someone ask for more on bond market liquidity?

Did someone ask for more on bond market liquidity?

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Marketmakerliquidity

 

The Bank for International Settlements has released a 57-page paper on bond market liquidity, mostly examining the issue from the perspective of shrinking capacity on the dealer-bank side. It comes with the above schematic and plenty of other interesting facts and charts.

See also FT Alphaville, where my colleague Izabella Kaminska has started a liquidity series.

October 15. A financial markets whodunnit.

October 15. A financial markets whodunnit.

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On October 15, prices of US government bonds – one of the most liquid markets in the world – whipsawed violently and sparked a wave of speculation on Wall Street as to the culprit(s) behind the wild moves.

Here’s a longish analysis of what happened. The key suspects: lack of liquidity, the rise of electronic trading, a classic gamma trap (possibly sparked by the scuppering of the AbbVie/Shire deal) and much, much more.

… On October 15, the yield on the benchmark 10-year US government bond, which moves inversely to price, plunged 33 basis points to 1.86 per cent before rising to settle at 2.13 per cent. While that may not seem like much, analysts say the move was seven standard deviations away from its intraday norm – meaning it might be expected to occur once every 1.6bn years.

For several minutes, Wall Street stood still as traders watched their screens in disbelief. Electronic pricing machines, which now play a bigger role than ever in the trading of Treasuries, were halted and orders cancelled by nervous dealers as prices see-sawed.

The events have sparked a financial “whodunnit” as investors, traders and regulators seek to understand what happened – and to determine whether October 15 was a unique event or a harbinger of further perilous trading conditions to come.

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Bonds: Anatomy of a market meltdown

Creditworthy or Not

Creditworthy or Not

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Here’s an analysis of how some corporate accounting shenanigans are playing out in credit markets, where aggressive earnings adjustments known as “add-backs” can make companies appear more creditworthy than their historical cash generation might otherwise indicate. The effect can be pretty darn substantial.

In the competitive world of online dating, men and women will embellish their profiles to attract the best mates. Salaries are engorged, ages are diminished and heights increased as singles seek promising partners.

In credit markets a similar trend is playing out as companies flatter their bottom lines to attract the best financing deals from investors who are willing to play along in order to get a shot at a debt product with juicy yields.

And here’s the key quote:

“Beauty – or the lack of beauty – is in the eye of the beholder,” says Scott McAdam, portfolio specialist at DDJ Capital Management. “In the late stages of a credit cycle where capital is cheap and there’s a lot of money chasing deals, companies will kind of get away with this.”

Credit markets play a risky dating game